ECB: Financial Tensions Ease 'Tangibly' but Risks Remain

The European Central Bank said there are still risks to financial stability in the euro area, even after tensions abated “tangibly” in the last half year.

“Key financial-stability risks remain and there is no room for complacency,” the Frankfurt-based central bank said in its biannual Financial Stability Review published in Frankfurt Friday. At the same time, “stresses on the euro-area financial system have eased tangibly since the summer, as the intensity of self-fulfilling and destructive confidence spirals has dissipated,” according to the report.

European stocks have rallied 20 percent since this year’s low on June 4 and bond yields in Spain and Italy have subsided after ECB President Mario Draghi on July 26 pledged to save the euro and subsequently unveiled and unlimited bond-buying plan that would be activated if a country asks for aid. Europe’s leaders have also charged the ECB with supervising the region’s lenders in an effort to bolster confidence in the banking sector and defeat the crisis that has roiled markets since late 2009.

“An unequivocal commitment by the ECB to combat unfounded concerns about euro revocability has played a key role in this development by mitigating the tail risks that had been priced in to financial-asset prices,” according to the report.

Pressure Eases

ECB Vice President Vitor Constancio said today that the bond-buying program and decision by governments on the “future deepening of integration in Europe” through measures including the banking union helped ease pressure on financial markets. Still, he told reporters in Frankfurt that “there is still a lot of pressure on the funding of banks.”

At the same time, the report reiterated that the central bank “cannot address the root causes” of the crisis and that broader policy action has “remained uneven across countries.”

The ECB identified three key risks to a stable financial system in the euro area: a renewed aggravation of the crisis due to waning government efforts, further deterioration in bank profitability and credit quality owing to a “weak macro-financial environment” and fragmented markets exacerbating “funding strains for banks in countries under stress.”

The functioning of money and debt markets has remained “impaired, notwithstanding ECB action,” such as cutting its deposit rate to zero and pumping more that $1 trillion into the banking system via three-year loans, according to the report.

“Strides toward improving fundamentals at the national level, whilst simultaneously working to sever sovereign-bank feedback loops, are critical to resolving the pernicious fragmentation of funding and capital markets,” the ECB said.